Tax News

CCH (cch.taxgroup.com) reports:

  The IRS has issued final, temporary and proposed regulations under Code Sec. 7874 addressing the treatment of foreign corporations as surrogate foreign corporations. The regulations affect mainly domestic corporations or partnerships (and certain parties related to them) and certain foreign corporations that acquire substantially all of the properties of such domestic corporations or partnerships. The regulations are effective on June 12, 2009.

Background

  A foreign corporation is generally treated as a surrogate foreign corporation under Code Sec. 7874(a)(2)( if pursuant to a plan or a series of related transactions (1) the foreign corporation completes the direct or indirect acquisition of substantially all of the properties held directly or indirectly by a domestic corporation; (2) after the acquisition, at least 60 percent of the stock (by vote or value) of the foreign corporation is held by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation; and (3) after the acquisition, the expanded affiliated group, as defined in Code Sec. 7874(c)(1), that includes the foreign corporation does not have substantial business activities in the foreign country in which, or under the law of which, the foreign corporation is created or organized, when compared to the total business activities of the expanded affiliated group. Similar provisions apply to transactions involving the acquisition by a foreign corporation of substantially all of the properties constituting a trade or business of a domestic partnership. The level of ownership in the surrogate foreign corporation by former shareholders of the domestic corporation or former partners in the domestic partnership determines the treatment of the transaction.

  In June 2006, the IRS issued temporary regulations (T.D. 9265) concerning the treatment of a foreign corporation as a surrogate foreign corporation, along with proposed regulations cross-referencing the temporary regulations (NPRM REG-112994-06 ). In July 2006, the IRS issued Notice 2006-70, 2006-2 CB 252, announcing that the effective date in Temporary Reg. §1.7874-2T(j) would be amended for certain acquisitions initiated prior to December 28, 2005. After considering the comments received on these regulations, the IRS has decided to withdraw the 2006 temporary regulations and the related proposed regulations and to replace them with the present temporary and proposed regulations.

Temporary Regulations

  Stock held by a partnership. The temporary regulations modify the rule of Reg. §1.7874-1(e) to apply only for purposes of determining whether the ownership condition of Code Sec. 7874(a)(2)((ii) is satisfied and provide other partnership look-through rules.

  Indirect acquisition of properties. The temporary regulations retain the 2006 temporary rules on indirect acquisitions of properties held by a domestic corporation and clarify that the identified transactions do not represent an exclusive list of transactions that constitute indirect acquisitions. The temporary regulations also clarify that the acquisition of an interest in a partnership is an indirect acquisition of a proportionate amount of the properties of the partnership for purposes of Code Sec. 7874(a)(2)((i).

  The temporary regulations also retain and modify the rule under which a foreign issuing corporation is treated as acquiring a proportionate amount of the stock or assets of a domestic corporation in the case where such stock or assets are acquired by another corporation in exchange for stock of the foreign issuing corporation, which directly or indirectly owns more than 50 percent of the stock (by vote or value) of the acquiring corporation after the acquisition. First, this rule is modified to apply if the acquiring corporation and the foreign issuing corporation are members of the same expanded affiliated group after the acquisition. Second, the rule is modified to apply to an acquisition of a partnership's properties. Finally, the rule is modified to apply if a partnership acquires properties of a domestic corporation or partnership in exchange for stock of a foreign issuing corporation, but only if the foreign issuing corporation and the partnership would be members of the same expanded affiliated group after the acquisition if the partnership were a corporation.

  Acquisitions by multiple foreign corporations and acquisitions of multiple domestic corporations. To address acquisitions by multiple foreign corporations intended to avoid Code Sec. 7874, the temporary regulations provide that if pursuant to a plan or a series of related transactions, two or more foreign corporations complete, in the aggregate, an acquisition described in Code Sec. 7874(a)(2)((i), then each foreign corporation will be treated as completing the acquisition for purposes of determining whether such a foreign corporation will be treated as a surrogate foreign corporation. With respect to acquisitions of multiple domestic corporations or partnerships, the temporary regulations clarify that if a foreign corporation completes more than one such acquisition pursuant to a plan or a series of related transactions, then, for purposes of Code Sec. 7874(a)(2)((ii), the acquisitions will be treated as a single acquisition and the domestic corporations and/or domestic partnerships will be treated as a single entity.

  "By reason of" standard. The temporary regulations clarify that the "by reason of" condition of Code Sec. 7874(a)(2)((ii) is satisfied if stock of a foreign corporation is received in exchange for, or with respect to, stock in a domestic corporation or an interest in a domestic partnership. This includes a taxable or nontaxable distribution. The "by reason of" condition may be satisfied other than through exchanges or distributions. In addition, the "by reason of" standard applies based on the amount of stock of the foreign corporation received in exchange for, or with respect to, the stock of the domestic corporation or interest in the domestic partnership. This determination is based on the relative values of the stock of the domestic corporation or interest in a domestic partnership and any other property exchanged for the stock of the foreign corporation.

  Substantial business activities condition. The temporary regulations do not retain the safe harbor for determining if the substantial business activities condition of Code Sec. 7874(a)(2)((iii) is satisfied or the examples illustrating the general rule provided by the 2006 temporary regulations. Thus, taxpayers can no longer rely on such safe harbor or the examples; instead, they must apply the general rule to determine whether the substantial business activities condition is satisfied. The temporary regulations also add to the items not taken into account in determining whether the substantial business activities condition is satisfied any assets, business activities or employees located in the foreign country in which the foreign acquiring corporation is created or organized if such assets, business activities or employees are transferred to another country pursuant to a plan in existence at the time of the acquisition. In addition, for purposes of the substantial business activities condition, a member of the expanded affiliated group that holds at least a 10-percent capital and profits interest in a partnership will take into account its proportionate share of the items of the partnership, including business activities, employees, assets, income, and sales.

  Publicly traded foreign partnerships. The temporary regulations also clarify that, for purposes of Code Sec. 7874, a foreign partnership is treat as a foreign corporation if the partnership would, but for
Code Sec. 7704(c), be treated as a corporation under Code Sec. 7704(a) at the time of the Code Sec. 7874(a)(2)((i) acquisition, or at any time after the acquisition pursuant to a plan that existed at the time of the acquisition. A publicly traded foreign partnership treated as foreign corporation under this rule is treated as a foreign corporation for all purposes of Code Sec. 7874.

  Options and similar interests. Under the temporary rules, for purposes of Code Sec. 7874, an option or similar interest in a domestic corporation or a domestic or foreign partnership will be treated as stock of the domestic corporation or an interest in the partnership with a value equal to the holder's claim on the equity of the domestic corporation or partnership immediately before the Code Sec. 7874(a)(2)((i) acquisition. An option or similar interest in a foreign corporation will generally be treated as stock of the foreign corporation with a value equal to the holder's claim on the equity of the foreign corporation immediately after the acquisition. These rules will not generally apply to the extent that treating an option or similar interest as stock of a corporation or an interest in a partnership would duplicate, in whole or in part, a shareholder's or partner's claim on the equity of the corporation or partnership.

  Economically equivalent interests. To address certain transactions intended to avoid Code Sec. 7874 that involve interests substantially equivalent to equity interests in foreign corporations, the temporary regulations provide that, for purposes of Code Sec. 7874, any interest, including stock or a partnership interest, that is not otherwise treated as stock of a foreign corporation will be treated as stock of the foreign corporation if the following two conditions are satisfied: (1) the interest entitles the holder to distribution rights that are substantially similar in all material respects to the distribution rights entitled to a shareholder of the foreign corporation by reason of holding stock in the foreign corporation; and (2) treating the interest as stock of the foreign corporation has the effect of treating the foreign corporation as a surrogate foreign corporation.

  Insolvent entities. The temporary regulations clarify that, for purposes of Code Sec. 7874, if immediately prior to the first date, properties are acquired as part of a Code Sec. 7874(a)(2)((i) acquisition, a domestic corporation is in a title 11 or similar case or the liabilities of the domestic corporation exceed the value of its assets, then any claim by a creditor against the domestic corporation will be treated as stock of the domestic corporation. A similar rule applies with respect to a domestic or foreign partnership. A creditor that is treated as a shareholder of a domestic corporation or as a partner in a partnership is treated as a shareholder or partner for all Code Sec. 7874 purposes.

  Modification to the internal restructuring exception. The IRS will issue regulations addressing the application of the internal group restructuring exception in Reg. §1.7874-1(c)(2) to certain divisive transactions. The regulations may apply to acquisitions completed on or after June 9, 2009.

  Effective and applicability dates. The temporary regulations generally apply to acquisitions completed on or after June 9, 2009. However, taxpayers may apply the temporary regulations to acquisitions completed prior to June 9, 2009, if the temporary regulations are applied consistently to all acquisitions completed prior to that date. The temporary regulations include the modifications announced by Notice 2006-70, 2006-2 CB 252, to the effective date of the 2006 temporary regulations for certain acquisitions initiated prior to December 28, 2005. These regulations will expire on or before June 8, 2012.

  Effect on other documents.
Notice 2006-70, 2006-2 CB 252, is obsolete as of June 9, 2009.

Proposed Regulations

  The text of the temporary regulations also serves as the text of the proposed regulations published simultaneously with the temporary regulations (NPRM REG-112994-06). Written or electronic comments and requests for a public hearing on the proposed regulations must be received by September 7, 2009.

T.D. 9453, 2009FED ¶47,021

Proposed Regulations, NPRM REG-112994-06, 2009FED ¶49,422

Other References:

 
Code Sec. 7874

  CCH Reference - 2009FED ¶43,970

  CCH Reference - 2009FED ¶43,970B

  CCH Reference - 2009FED ¶43,970C

  Tax Research Consultant

  CCH Reference - TRC INTL: 30,082.05